During my working career as an equity portfolio manager, I experienced the US bear markets of 1980-82, 1987, 1990-91 and 2000-2002. Because I spent the majority of my career as a global manager, I also lived through the collapse of the Japanese stock market (then by far the largest in the world) in 1989 and the currency-triggered bear market in many smaller Asian countries in the late 1990s. I started writing this blog as a way of helping myself think about the bear market of 2007-09 and what would follow.
In other words, for equity managers there have been lots of bad times to help us along with the painful process of being able to, as they say, make the critical distinction between brains and a bull market.
Also, the bad periods themselves have been long enough to force us to recognize that different investment styles (growth or value) work best in different economic circumstances. We certainly won’t change our overall philosophies. However, successful equity managers all realize that for them there are some times to be in fifth gear with the gas pedal to the floor and others to be in second gear and tapping on the brakes.
Looking at the bond world from the outside, it seems to me that little of this has been the case for bonds and bond managers since the early 1980s. Yes, junk bonds or emerging markets debt may have gotten ugly now and again. Nevertheless, the continual decline in interest rates from the early Volcker years to the present has made for a remarkably smooth, and consistently bullish, ride for bond investors and managers.
The amazing part is not a long bullish period–after all, equities in the US had that for most of the 1990s–but the fact that the benign environment lasted over thirty years. To have experienced an ugly time for bonds comparable to what happens to stocks every business cycle, you would have to have been a bond manager in the 1970s!
This is my main concern for actively managed bond funds.
We’re (already) in a period in which interest rates are not going to decline. They may fluctuate for a while, even a long while, but the new main trend is going to be for rates to rise. And we haven’t had circumstances that have forced bond managers to cope with a situation like this for decades.
Instead, the recipe for success over the past thirty-five years has been to throw caution to the winds and bet as heavily as possible on continuously declining rates. The most successful managers would have been the most aggressive, the ones willing to double down on any bet gone wrong and to stack their portfolios full of risk. Brash, bold, stubborn, no sense of nuance, not the brightest crayon but tenacious. Think Jon Corzine and what happened to him.
Will bond fund managers be able to adjust to the changing trend? I don’t know.
Bill Gross is another interesting case in point. He became the “bond king” by betting aggressively on lower interest rates. My reading of his results for his last several years at Pimco is that he tried to keep his performance numbers up by layering on extra amounts of risk to the main bet that had stopped providing results. That didn’t work so well, in my view. Since leaving for Janus, where he could express his ideas in his portfolio without an outside sanity check (outside interference?), he’s done poorly.
This is not about old dogs and new tricks in the sense of age but only in having the temperament and mental flexibility to adjust to changing circumstances.